REA Group Still Overvalued Despite Respectable Performance in Tough Market (Corrected)

Narrow-moat-rated REA Group’s fiscal 2020 financial result was broadly in line with our expectations and we have maintained our fair value estimate at AUD 80 per share. However, at the current market price of AUD 115, we continue to believe the shares are overvalued. Over the past five years, REA Group’s price/earnings multiple has increased to around 50 from 30 despite earnings growth slowing sharply in fiscal 2019 and turning negative in fiscal 2020. We expect the share price is mainly being driven higher by the low interest rate environment and that earnings risk is being overlooked by investors to some degree.In the five years before fiscal 2019, REA Group’s Australian business achieved average revenue growth of 20% but revenue grew by just 9% in fiscal 2019 and fell by 7% in fiscal 2020. However, we attribute recent weakness to relatively short-term macroeconomic events and expect revenue to rebound and return to growth from fiscal 2021. Importantly, REA’s leading market position remains intact.From a balance sheet perspective, REA Group remains in excellent shape with net debt of just AUD 104 million as at June 30, 2020, or just 0.2 times annual EBITDA, with EBIT covering interest expenses a very strong 88 times. We think it’s highly unlikely the company would need to undertake an equity raising and we consider the dividend to be highly sustainable. If anything, REA Group’s challenge will be to justify its relatively undergeared balance sheet to some investors which may encourage management to consider acquisitions. However, considering the lack of success historically in this regard, we’d be wary of, particularly large acquisitions and would prefer to see the company innovate and grow organically.